There are two kinds of debt: secured and unsecured. A debt is secured when the creditor/lender can recover a specified asset from the debtor/borrower if the borrower does not repay the loan on time. A car loan is an example. A borrower does not have to give collateral to receive the loan or services with unsecured debt. One example is medical bills. If a debtor has doctor bills when they file bankruptcy, the doctor/creditor will not get paid and there is nothing they can do about it.

Secured Debt

However, the situation is very different when a debt is secured. Examples of secured debt are home mortgages and car loans. If a debtor gets behind on their home mortgage, the creditor can foreclose on that house by filing a lawsuit against the debtor.

Secured debt is any debt that uses a piece of property as collateral. The property can be large, like a home or a car, or it can be something smaller like a guitar or entertainment system. Some lending companies require collateral for personal loans, making them secured debts. If you default on these loans, the lender can seize the property to cover the debt.

There are two parts to a secured debt: personal liability and security interest. Personal liability is your obligation to pay the debt. The security interest (lien) is the creditor’s claim to the property you used as collateral to secure the debt.

If your debt is the kind that can be discharged in bankruptcy, your personal liability will be erased with Chapter 7 bankruptcy. Once that happens, the lender can no longer sue you to collect money for the debt. However, liens are unaffected by bankruptcy discharges. If you don’t stay current with payments, you can lose your collateral even if your personal liability has been discharged.

Secured debts are often easier to acquire if your credit isn’t perfect because the bank has something they can take from you if you don’t pay them. How is secured debt handled when you file bankruptcy under Chapter 7?

A person with secured debt who files Chapter 7 bankruptcy has three options for resolving the debt. Those three choices are:

• Surrender
• Redeem
• Reaffirm

 

Surrendering Collateral

If the debtor has a secured loan for a truck they cannot afford, they can surrender, or return, the truck to the creditor after filing bankruptcy. Doing so makes it as if the secured loan was never made. It does not matter if the debtor was behind on their installment payments or not. If they do not wish or cannot afford to continue paying the loan, the debtor can surrender the item to the creditor who loaned them the money to buy it in the first place, and the debt is discharged.

You can also choose to surrender your home when filing Chapter 7 bankruptcy if you can no longer make the mortgage payments. To do so, you make your intention known to the court and your lender when you file the Statement of Intentions form. The lender sells the property at auction to the highest bidder, and your obligation is discharged even if the property sells for less than you owe.

 

Redeeming Your Debt

To redeem a secured debt, a debtor makes one lump sum payment to the creditor in order to keep the item in question. The experienced bankruptcy lawyers at Morgan & Morgan would negotiate with that creditor for the best possible price for the item. Because there are laws governing how much money a person pursuing bankruptcy can have when they file, and statutes dictating how valuable assets they own can be when they file, we work closely with our clients to determine if redeeming is a viable option for secured debt or not.

When you are redeeming property in Chapter 7 bankruptcy, you and the creditor come to an agreement about the value of the property. The court will decide the value for you in a valuation hearing if you can’t come to an agreement with your creditor. If the court approves the redemption of your property, it is yours free and clear once you pay the creditor a lump sum. You can only redeem the property by meeting the following criteria.

• The property must be used for personal or household purposes. You can’t redeem collateral for business debts in a personal Chapter 7 case.
• It is personal property, which is anything other than real estate. Real estate is not redeemable under Chapter 7.
• It must be tangible (touchable) property. You must be able to see and touch the item; it can’t be investments, intellectual property rights, stocks, or bonds.
• It has no value to the bankruptcy case. In other words, it must meet the criteria for an exemption either through the state or because the trustee deems it of little value.

One advantage to redemption is if you owe substantially more than the property is worth, you get it at its current value. However, the disadvantage is that you have to pay for it in one lump sum, which can be difficult for someone filing bankruptcy.

 

Reaffirming Your Debt

Reaffirmation, the third option, is by far the most popular. When a debtor reaffirms a secured debt, they sign a contract with the creditor stating that despite filing bankruptcy, they wish to keep the secured item and continue paying the loan as if they had not filed bankruptcy. They keep paying on the debt under the same conditions as their original contract.

Under the U.S. Bankruptcy Code, a debtor has to be current on their payments in order to request a reaffirmation. In other words, if they have missed some payments along the way before filing bankruptcy, a debtor can’t request a reaffirmation of secured debt.

In addition to being current on payments, the property must meet the criteria for exemption. If you can’t exempt the property’s value, the trustee will likely deem it valuable to the case and have it sold. Once the property is sold, the proceeds go toward paying your unsecured debts.

If you reaffirm a debt, you agree that you still owe that debt even after bankruptcy. The lien and your personal liability remain intact. Basically, it will be like you never filed bankruptcy as far as that debt is concerned.

Reaffirmation allows you to keep your property provided you abide by the terms of your agreement to reaffirm the debt and keep your payments current. The lender can’t take the property as long as you maintain a current status with your payments. In some cases, you can renegotiate your loan in the process of reaffirmation. When this happens, you may have lower prices, a better interest rate, or a lower total amount to pay.

The disadvantage to reaffirmation is if something happens to the property after reaffirmation, you are still liable for the debt. For example, if you default on your car loan and they sell the car for less than you owe, you will be billed the difference. Or, let’s say you reaffirmed a guitar valued at $2,000, and a month later, the guitar is destroyed in an accident. You will still owe the money for the guitar even though you no longer have it.

If you’ve decided to try to reaffirm your property, you or your lender must file your agreement with the court as part of your bankruptcy proceeding. Keep in mind that the judge still has the ability to say no to the agreement. If a reaffirmation rejection occurs, it’s usually because the judge doesn’t think you’ll be able to maintain the payments and manage basic living expenses or because what you owe is substantially more than the property is worth.

If for whatever reason, secured debt cannot be reaffirmed, a debtor must either redeem or surrender the collateral. They cannot simply keep the asset without making written payment arrangements with the creditor.

As bankruptcy attorneys, it is our job to ensure our clients understand what can happen to their secured and unsecured debts if a Chapter 7 bankruptcy is filed.

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